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There are a lot of things to worry about in life, but the gift tax probably isn’t one of them.
What is the gift tax?
Gift tax is a federal tax on transfers of money or property to other people while getting nothing (or less than full value) in return. Few people owe gift tax; the IRS generally isn’t involved unless a gift exceeds $15,000. Even then, it might only trigger extra paperwork.
Do you pay taxes when you receive a gift?
In most cases, no. Assets you receive as a gift or inheritance typically aren’t taxable income at the federal level. However, if the assets later produce income (perhaps they earn interest or dividends, or you collect rent), that income is likely taxable. IRS Publication 525 has the details. Also, some states have inheritance taxes.
How do I avoid gift tax?
Two things keep the IRS’ hands out of most people’s candy dish: the $15,000 annual exclusion in 2020 and 2021, and the $11.58 million lifetime exclusion in 2020 ($11.7 million in 2021). Stay below those and you can be generous under the radar. Go above, and you’ll have to fill out a gift tax form when filing returns — but you still might avoid having to pay any gift tax.
How gift tax is calculated and how the annual gift tax exclusion works
In 2020 and 2021, you can give up to $15,000 to someone in a year and generally not have to deal with the IRS about it.
If you give more than $15,000 in cash or assets (for example, stocks, land, a new car) in a year to any one person, you need to file a gift tax return. That doesn’t mean you have to pay a gift tax. It just means you need to file IRS Form 709 to disclose the gift.
The annual exclusion is per recipient; it isn’t the sum total of all your gifts. That means, for example, that you can give $15,000 to your cousin, another $15,000 to a friend, another $15,000 to the neighbor, and so on all in the same year without having to file a gift tax return.
The annual exclusion also is per person, which means that if you’re married, you and your spouse could give away a combined $30,000 a year to whomever without having to file a gift tax return.
Gifts between spouses are unlimited and generally don’t trigger a gift tax return. Gifts to nonprofits are charitable donations, not gifts.
The person receiving the gift usually doesn’t need to report the gift.
How the lifetime gift tax exclusion works
On top of the $15,000 annual exclusion, you get an $11.58 million lifetime exclusion (in 2021, that rises to $11.7 million). And because it’s per person, married couples can exclude double that in lifetime gifts. That comes in handy when you’re giving away more than $15,000.
“Think about buckets or cups,” says Christopher Picciurro, a certified public accountant and co-founder of accounting and advisory firm Integrated Financial Group in Michigan. Any excess “spills over” into the lifetime exclusion bucket.
For example, if you give your brother $50,000 this year, you’ll use up your $15,000 annual exclusion. The bad news is that you’ll need to file a gift tax return, but the good news is that you probably won’t pay a gift tax. Why? Because the extra $35,000 ($50,000 – $15,000) simply counts against your $11.58 million lifetime exclusion. Next year, if you give your brother another $50,000, the same thing happens: you use up your $15,000 annual exclusion and whittle away another $35,000 of your lifetime exclusion.
The gift tax return keeps track of that lifetime exemption. So if you don’t gift anything during your life, then you have your whole lifetime exemption to use against your estate when you die.
What is the gift tax rate?
If you’re lucky enough and generous enough to use up your exclusions, you may indeed have to pay the gift tax. The rates range from 18% to 40%, and the giver generally pays the tax. There are, of course, exceptions and special rules for calculating the tax, so see the instructions to IRS Form 709 for all the details.
What can trigger a gift tax return
Caring is sharing, but some situations often inadvertently trigger the need to file a gift tax return, pros say.
Spoiling the grandkids with college money
Picciurro explains it like this. “Let’s say Grandma and Grandpa say, ‘We don’t really like your husband and we don’t really like you, but we really like our grandkids. So we’re going to give $60,000 and we’re going to put it in a 529 plan for them so their college is paid for.’ Well, Grandma and Grandpa just triggered the gift tax exclusion because it’s over [$15,000].”
A special rule allows gift givers to spread one-time gifts across five years’ worth of gift tax returns to preserve their lifetime gift exclusion.
Springing for vacations, cars or other stuff
If you fork out $40,000 for Junior’s wedding, or just pay for the crazy-expensive honeymoon, get ready to do some paperwork.
If you’re paying tuition or medical bills, paying the school or hospital directly can help avoid the gift tax return requirement (see the instructions to IRS Form 709 for details).
Lending money to friends and family is usually a bad idea, and the IRS can make it even worse. It considers interest-free loans as gifts. Or if you lend them money and later decide they don’t need to repay you, that’s also a gift.
Elbowing in on a non-spouse bank account
“Let’s say you live by Grandma, so for convenience, we’re going to put you on Grandma’s bank account. Guess what just happened?” Picciurro says. “If you’re put as a joint [owner] on a bank account with somebody and you have the right to take the money out at any time, essentially Grandma is giving you a gift.”